Chapter 4: A Model of the Relationship between Norms of Equity, Reference Level Norms and Skill-based Wage Differentials
4.1 INTRODUCTION In the previous chapter the possibility of a relationship between individuals’ concerns about the fairness of their wages (based on norms, such as those of equity) and the determination of wage levels was introduced. It was noted that efﬁciency wage models have been developed to capture these ideas at a theoretical level. This chapter examines an efﬁciency wage model that was developed by Fehr, Kirchsteiger and Riedl (1993), Fehr and Kirchsteiger (1994) and Fehr and Schmidt (1999). These authors extended the basic efﬁciency wage framework to explore the link between fairness judgments and wage relativities. As in the standard fairness efﬁciency wage models, the model of Fehr et al. emphasizes workers’ concern for fairness and relates these concerns to workers’ effort levels. However, it is distinguished by a focus on the importance of the perceived fairness of wage relativities between groups of workers, speciﬁcally incumbent and new workers, rather than on the question of the fairness of general wage levels. In this chapter the model of Fehr et al. is adapted to enable an examination of the importance of beliefs about the fairness of established skill-based wage differentials. An important characteristic of the labour market is that skill-based wage differentials tend to be stable over long periods of time, despite evidence of changing market conditions. The stability of these differentials has also been attributed a role in producing cyclical unemployment. The extension of the Fehr et al. model that is presented in this...
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